The Bush Tax Cuts: If we account for how the cuts are paid for, who benefits from them?

The Bush tax cuts will be financed in the future by some combination of tax increases and spending cuts, but it is impossible to say today what the mix will be. TPC has estimated changes in tax burdens across income groups under a variety of assumptions about how the tax cuts will eventually be paid for. In all of these hypothetical scenarios, two common conclusions emerge: a majority of households are made worse off by the tax cuts, and the net effect of the tax cuts is a transfer of wealth from lower-income households to wealthier households.

We examine here two of these hypothetical scenarios. In both, for ease of comparison, the financing is set so that the cost of the tax cuts (that is, the revenue lost) in a given year is fully paid in that same year. The first scenario assumes that the cost is divided equally among all households, so that each pays the same dollar amount to finance the tax cuts. In this scenario each tax unit "pays" $1,869 (in 2010 dollars) in some combination of reductions in benefits from government spending or increases in taxes other than income tax. Something close to this "lump-sum" or "equal-dollar" financing scenario could occur if the tax cuts were financed largely or entirely through spending cuts that affected all households equally. The second scenario assumes that each household pays the same percentage of its income to finance the tax cuts. In this case the cost per household is 2.6 percent of its income. Something close to this "proportional financing" scenario could occur if the tax cuts were financed through a combination of spending cuts and progressive tax increases.

Under equal-dollar financing, every measure of the distributional effects shows that high-income taxpayers would gain and all other taxpayer groups would lose if the tax cuts were made permanent (see table 1). Those made worse off include almost every household in the bottom 40 percent of the income distribution, 94 percent in the middle quintile, and even 80 percent in the fourth quintile; in all, 76 percent of taxpayers would be made worse off. In sharp contrast, 89 percent of taxpayers in the top quintile and 95 percent of households in the top 1 percent end up better off, receiving average benefits of more than $54,000.

The assumption of proportional financing yields similar results (table 2): again, all of the measures indicate that high-income households would be better off, while other households as a group (and about 80 percent of all households, including a majority in every quintile) would be worse off. The top quintile is the only group to receive a net tax cut, but even within that group almost two-thirds of all households in the 80th to the 99th percentile would face net tax increases. In addition, both of the measures that did not show greater gains for the highest-income households when financing was ignored-the reduction in total federal tax liability and the share of income tax paid-now also show that households in the bottom 80 percent of the income distribution would be worse off on average, while those in the top quintile would be better off.

Further Reading

Burman, Leonard E., "Fairness in Tax Policy," testimony before the Subcommittee on Financial Services and General Government, U.S. House Appropriations Committee (Washington: Urban-Brookings Tax Policy Center, March 2007).